Media of Exchange and Unit of Account, Legal Tender and Forced Tender in El Salvador
In Intermediate Macro, I teach about the the functions of money: medium of exchange, unit of account and store of value. Sometimes standard of deferred payment is added as a fourth function. It is good to have examples. El Salvador now has some interesting ones for medium of exchange and unit of account. (Almost anything is a store of value, so that is the least interesting function. The closest I can come to something that isn’t a store of value but is a medium of exchange is a credit card.)
Since 2001, the unit of account in El Salvador—which is also a medium of exchange—has been the US dollar. In their June 22, 2021 Wall Street Journal op-ed “El Salvador’s Big Bitcoin Mistake,” Steve Hanke and Manuel Hinds write:
Twenty years ago, after years of painstaking preparation, weeks of congressional deliberation, and a green light behind the scenes by the U.S. Treasury and the International Monetary Fund, El Salvador effectively mothballed its currency, the colón, in 2001. The U.S. dollar officially became the coin of the realm.
Dollarization has worked: Since 2001, the average annual inflation rate has been 2.03%—the lowest in Latin America.
Since June 8, 2021, by law, anyone offering a good or service in El Salvador must accept Bitcoin as a medium of exchange. But Bitcoin is not a unit of account in El Salvador. That is, people still primarily think about and record values in terms of dollars, not in terms of Bitcoin.
In addition to giving an example of a medium of exchange that is not a unit of account, El Salvador’s Bitcoin Law also points to an important distinction about what legal tender is and what it isn’t. In the US, legal tender means that preexisting debts can be paid in dollars, but doesn’t mean that merchants must sell to someone offering dollars. Steve Hanke and Manuel Hinds write:
Legal-tender laws, like those in the U.S., only specify what currencies discharge debts, including the payment of taxes. Forced-tender laws remove the freedom of choice in the use of currencies for all transactions, including everyday purchases like groceries. When forced tender is imposed, all domestic exchanges, including those that traders would rather conduct in another currency, must be conducted in the currency designated by law.
They then give Soviet and Nazi examples of forced tender laws.
Personally, I have been interested in the distinctions between medium of exchange and unit of account and the details of what legal tender means because these distinctions and details matter for negative interest rate policy. On negative interest rate policy, see my bibliographic post “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.”